Grandparents who want to pay all of their grandchild’s college tuition are a blessing. The key word there is “all.” Most of us remember our grandparents contributing to our college fund by buying saving bonds for our birthdays. Nowadays, grandparents can contribute to 529 plans along with parents, pooling their money and allowing the assets to grow.

However, some grandparents prefer to open their own 529 plans with their grandchild as the beneficiary. This, again, would be a blessing if the account assets were enough to cover four years of tuition, books, and room and board at a prestigious university. More often, these assets just assist with a much larger bill that is often funded through student loans and financial aid.

On the Free Application for Federal Student Aid, student assets, such as, a savings account or custodial account, generally reduce financial aid eligibility by 20 percent of the asset’s value. Parent assets, like parent-owned 529 plans, investment property or brokerage accounts, generally reduce need-based financial aid by a maximum of 5.64 percent of the asset’s value. A grandparent’s assets, like a grandparent-owned 529 plan are ignored. This may seem like a good plan; however, once the grandparent begins withdrawals from the 529 plan, those assets are then considered untaxed income to the beneficiary. Those assets are then taken into consideration on the following year’s financial aid application. Generally, this reduces the student’s financial aid eligibility by 50 percent. Ouch!

Let’s say a student’s parents have $35,000 in a 529 plan. This could reduce the student’s financial aid by $1,974. If a grandparent owned the account and withdrew $10,000 to pay for the student’s first year of tuition, in the following year, that $10,000 would be considered untaxed income to the student. This scenario should reduce financial aid for the following year by $5,000.

Divorced parents may also run into similar problems if a non-custodial parent owns a 529 plan, because the withdrawals will be considered income; thus, reducing financial aid, like grandparent-owned assets.

To avoid this, grandparents may want to consider transferring the ownership of the 529 plan to the parents before the grandchild starts college. While Georgia’s 529 plan allows ownership transfers, some plans do not. If this is your situation, you may need to transfer the money to another state’s plan before changing the account owner. While the funds in the plan will then count as parent assets, it will not count as income. Therefore, it should have a smaller impact on the aid calculation.

Another option is to wait until the 529 plan assets are sufficient to cover the remaining college expenses without the need for financial aid. If you will still need financial aid, you may consider waiting until after January 1st of the student’s junior year before taking withdrawals from the plan. By then, the income should not affect the financial aid calculation, as it is based on the previous year’s assets and income.

William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.

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